More Prediction Follies

The cartoon above depicts what some describe as the “greed/fear” cycle of investing. As investors, we tend to finally jump into the market when it finally reaches a high point. You hear statements like “I don’t want to miss out anymore on the So-and-So Fund’s return, because it’s been up for six months in a row.” That represents the greed part of the investing cycle, otherwise known as buying high.

At the other end is the fear section of the investing cycle, aka selling low. Once the market has really gone down a bit, we capitulate and sell because “I can’t take these losses anymore. Who knows how much lower this market will go?”

But I think if you look a bit closer at the cartoon, you’ll see it also represents more prediction follies. We make investing decisions based on greed because an investment has already had a good run, so we (knowingly, or more likely unknowingly) believe it will continue to perform well in the future. Often we make that judgment based on recent investment performance. Thus we project what’s happened over the last few weeks or months into the future and assume that positive trend will continue.

The reverse is also true. After a few weeks or months of down performance, we assume an investment will continue to go down, predicting in essence further losses. And again, we often make that prediction unconsciously.

Either way, the final leg of the investing cycle eventually comes about: we go broke. We lose much more than we gain. Is the culprit really fear or greed? Or is it that we unknowingly make predictions about the future? The end result is the same–losing money.

How can we break the “go-broke” cycle of investing?

  1. Have a long-term investment plan. Stick to it, regardless of what friends, family, colleagues at work, or financial “experts” say about the current markets, economy, interest rates, inflation, etc.
  2. Stop trying to predict the future. Recognize your limitations as an investor. No one knows with certainty what will happen in the markets next month/quarter/year/decade. So don’t fool yourself (and don’t let any expert fool you) into thinking you’ve got “advance knowledge” or some sort of superior insight.
  3. Build a well-diversified portfolio of stocks, bonds, real estate and natural resources. Rebalance your portfolio regularly to take advantage of opportunities to sell high and buy low, the only true recipe for long-term wealth creation.

What are your ideas for not going broke with your investments?

 

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About Mike Wilson

Michael L. Wilson, MBA, CFP®, CRC®, is the owner of Integrity Financial Planning. Prior to founding Integrity in 1998, he worked for two years as a faculty member at the College for Financial Planning in Denver, training other financial advisors. Mike has 10 years of experience in the mutual fund industry, having worked with Fidelity Investments and Invesco Mutual Funds. He holds an MBA in Finance from Baylor University. Learn more about his work at www.integrityplanner.com.
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